How do you make a roomful of risk-averse lawyers squirm? Tell them they can't buy their malpractice insurance.
That's exactly what U.S. Bankruptcy Judge Dennis Montali did on Wednesday when he denied defunct Heller Ehrman's request to purchase three years of malpractice insurance, agreeing with the creditors committee that the risks did not outweigh the estimated $10.2 million price tag.
"The committee gets to say how they want their money spent at the moment," Montali said.
The decision came after an hourlong debate that included testimony from former Heller Ehrman partner Paul Sugarman on the merits of purchasing malpractice insurance.
The debate centered around how the bankruptcy would affect the payment of judgments in a hypothetically successful malpractice suit.
Montali concluded that the diluting effect of the bankruptcy on all creditors' claims meant it was unlikely a claim would surpass the $2 million deductible of the insurance policy. If all creditors are getting 10 percent of what they are owed, a malpractice plaintiff with a $10 million judgment would get $1 million and -- even if Heller had racked up $750,000 in attorney fees defending the case -- it still wouldn't trigger a payout from the insurance.
Thomas Willoughby, a partner at Felderstein Fitzgerald Willoughby & Pascuzzi which represents the committee, said it was premature to make a decision when no one knows how diluted the claims will become.
"I hope this is nowhere near to a 10 percent case, or a 1 percent case. But we don't know if it's 10 percent or 70 percent," Willoughby said. "This [insurance] was negotiated pre-petition with the thought that no filing would occur. But once a filing occurs, the rules change and the economics change."
Heller was apparently not able to purchase the insurance before it filed for bankruptcy on Dec. 28 because its banks had frozen its accounts. The firm had attempted for three months to dissolve, but ran up against litigation with its landlords and what it called an uncompromising stance on the part of the banks.
The creditors committee had opposed the motion to pay the insurance after feedback from its financial adviser, saying it made "no economic sense."
"This was a very difficult choice for our committee," Willoughby said. "We could look stupid buying it, or we could look stupid not buying it."
In addition, the bankruptcy puts a stay on all suits, including any future malpractice suits. The bankruptcy judge would have to remove the stay to allow a trial. If a judgment were granted, the plaintiff would line up with all the rest of the unsecured creditors waiting for an inevitably diluted payment on a claim. Former partners could also be individually liable, but they are not usually the target of malpractice suits because firms have deeper pockets. Heller's existing insurance expires April 15.
John Fiero, a partner at Pachulski Stang Ziehl & Jones, which represents Heller, put his best case forward on how the insurance would transfer risk away from the estate, but Montali was not persuaded.
"That's a good argument for a law firm that is practicing law in the future. For a debtor that is out of business and is in liquidation mode and the best it can say is its creditors are maybe going to do so many cents on the dollar, that's exactly what would motivate, I would think, even a tenacious, aggressive malpractice creditor to settle, rather than to fight over discounted dollars," Montali said.